Can the New Angel Law Save Israeli High-Tech?

This year, the Israeli high-tech sector has faced significant challenges. Amidst political instability in Israel, investment levels have seen a notable decline compared to global standards. As the driving force behind the Israeli economy, the high-tech industry is experiencing setbacks. Tax revenues from this sector are dwindling, painting an uncertain future.

In response to such challenges, regulators often intervene to boost economic activity before it reaches a critical point. That’s precisely what we’re witnessing now. Last month, Knesset members passed the “New Angels Law” in both its second and third readings. This legislation is designed to bolster the growth of Israeli start-ups and tech companies at large.

The law specifically targets companies with their primary operations and intellectual property based in Israel. It offers preferential tax treatments for foreign financial institutions investing or lending to Israeli entities. 

While the tax advantages outlined in the legislation were initially set to expire in 2025, they have been extended through the end of 2026.

Can the law’s benefits revitalize the high-tech industry?

The legislation offers tax incentives for both individual investors and corporations. Given that numerous angel investors and investment firms funnel their funds through corporations, these corporate benefits are crucial. The law grants tax breaks on interest and offers perks for investments in publicly traded companies, thus motivating businesses to pursue public listings by incentivizing investments in such entities.

What key advantages does the law offer?

The foremost advantage is a tax credit ranging between 25% to 30% for individual investors, often referred to as “angel investors,” on investments up to NIS 4 million. To put it in perspective, if a venture capitalist invests one million dollars, they’re eligible to reclaim nearly $250,000 as a tax deduction from other income sources. Why does this matter? It allows an angel to immediately channel $250,000 into another startup, a significant sum at the seed funding phase. Should they invest that $250,000, they’d be entitled to an additional $62,500 back, enabling them to diversify their investments, perhaps in a Pre-Seed round.

Who qualifies for these advantages?

The law extends its benefits to both individual investors and investment partnerships. Before committing funds, it’s advisable to consult with an accountant. This expert can verify if the targeted R&D company aligns with the criteria necessary to capitalize on these incentives.

Another benefit involves the handling of capital gains tax. When executing secondary transactions or entries – essentially any realization transaction – both small individual investors (“angel investors”) and investment partnerships have the option to defer their capital gains tax by reinvesting in another startup. Deferring tax is a pivotal strategy for investors. This is grounded in the belief that a deferred tax equates to a saved tax. And as that money remains untouched, it continues to be invested and generate returns.

The advantage effectively allows a deferral on actual capital gains up to NIS 5.5 million, provided a subsequent investment is made within 12 months following the eligible sale date or up to four months prior. The regulatory body has clarified that investors cannot double-dip on benefits – meaning each investor can claim only one of the specified advantages.

How might this reshape the sector?

While the law aims to bolster smaller enterprises, these fledgling companies may not immediately discern the legislation’s direct impact on their growth trajectory. But what of the more established investor entities? The legislation permits a tech company, whether local or international, to classify the takeover of another tech entity as a current tax-deductible expense, spread over five years. This advantage manifests as a 20% reduction in the cost of acquiring shares in the eligible firm. By the conclusion of this timeframe, the acquiring entity can offset the total cost of procuring the qualifying shares against its revenue (excluding any positive equity amount).

In reality, despite the law’s intended objective, the actual utilization of its benefits appears to be quite restricted. It doesn’t seem to sufficiently incentivize investors to support emerging companies in their formative stages.

Another provision outlined in the law is a tax exemption for foreign financial institutions. This exemption pertains to their income from interest or linkage differentials paid by an Israeli company as repayment for a loan provided by that institution. This exemption is applicable for loans issued between July 25, 2023, and the conclusion of 2026.

Additional stipulations for eligibility for this benefit include that the loan must be granted to a company whose technological revenues surpassed NIS 30 million in the tax year prior to the date of the loan’s issuance. Furthermore, the loan must be dispensed in cash and amount to a minimum of 10 million dollars.

In reality, it appears that only the sizable and profitable companies will benefit from this provision, given the limited number of companies that can secure loans from financial institutions, especially foreign ones. As a consequence, smaller high-tech enterprises may likely be left on the sidelines.

For foreign financial institutions, this provision is highly attractive, as it essentially allows them to receive a higher net return on the loans they extend, serving as an added compensatory measure for a potential decline in Israel’s credit rating, which invariably impacts the lending companies. It seems improbable that this benefit will translate to the borrowing companies; they may likely face unchanged interest rates compared to those before any downgrade, whilst the profits of financial entities might see an uptick owing to the law’s stipulations. 

Another plausible scenario is where the interest rates provided to Israeli high-tech firms on loans remain equivalent to those existing before any potential degradation in the credit rating of the State of Israel, implying a substantial impact of the law. But how probable is this scenario? Personally, I remain skeptical.

Extension of the capital loss offset benefit

Beyond the aforementioned advantages, the new law has extended the benefit related to offsetting capital losses on investments in private R&D firms until the end of 2028. For investments made in R&D companies listed on the stock exchange, this benefit will extend until the end of 2026.

This stipulates that an approved investment in the shares of an R&D firm will be acknowledged to the investor as a capital loss in the year the investment is made, or in subsequent tax years (up to two years later), with a cap of 5 million NIS. The law confines this benefit solely to qualified investments in R&D companies, specifically those with a market value ranging from 100 million NIS (down from the previous 200 million NIS) to 1 billion NIS.

De facto, I’m skeptical that this provision will be the catalyst to rejuvenate the high-tech industry. Investments in growing tech companies don’t seem to offer investors significant advantages from this benefit. If the intent was indeed to motivate these investors, it appears the regulatory body may have slightly missed the mark.